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MUMBAI: How did two employees try to fool a stodgy bank in the largest diamond house fraud that surfaced on Valentine’s Day, when thousands of
pearls and gems change hands across the world?

In raising funds and moving money out of Punjab National Bank (PNB), the two employees of the state-owned lender directly used SWIFT — the global financial messaging service used to move millions of dollars across borders every hour — and bypassed the core banking system (CBS) which processes daily banking transactions and posts updates.

It was a ploy to avoid immediate detection: the SWIFT messages used to raise overseas credit were not readily available in PNB’s FINACLE software system as these were issued without entering into the bank’s CBS.

What Really Happened?It began with diamond firms approaching PNB for opening letters of credit for import of rough stones. As per the terms of the LC, a common banking tool, PNB would pay the overseas suppliers on behalf on Nirav Modi’s firms within a certain period (typically three months) and recover the money from Modi. It’s a market practice to extend the LC if the client (i.e, NM) is unable to cough up the money at the end of the LC tenure.

Fake LoUs were IssuedThis is done on the basis of letters of undertaking given by the local bank (which in this case is PNB).

PNB employees issued fake LoUs, on the back of which foreign branches of a few Indian banks — including Axis and Allahabad Bank — gave dollar loans to PNB. These foreign currency loans were used to fund PNB’s Nostro accounts and from these accounts funds moved to certain overseas parties. A Nostro account is the account an Indian bank (here, PNB) has with an overseas bank.

Based on unauthorised Lo-Us, the PNB employees misused the SWIFT network to transmit messages to Allahabad Bank and Axis Bank on fund requirement. In using SWIFT, one has to log into the network to fill up fields like the account number and SWIFT code, following which it is endorsed by a supervisor. The process is completed when the bank receiving the message confirms and the details are validated. While all this was done using SWIFT passwords, the transactions were never recorded in the bank’s core system — thus keeping the PNB management in the dark for a long time.

The other question that crops up is: who were the suppliers? In the closely-knit world of diamonds, the overseas suppliers of rough stones and the final exporters of diamonds (after these are cut and polished in Surat) are often members of the clan, if not same family. According to PNB’s statement to enforcement agencies, the funds so raised for payment of import bills have not been utilised for such purposes in many cases.

According to banking circles, PNB will have to make good the lost money even though technically Allahabad Bank and Axis Bank took the exposure. “It is not known whether Axis and Allahabad still have the loans on their books or they have offloaded some of it to other banks,” said another banker.

According to a confidential note from PNB to some banks, similar modus operandi was used by the same officials in companies belonging to Mehul Choksi-promoted Gitanjali Gems, Gili India and Nakshatra, while issuing LoUs/ LCs. The transactions were initially routed through the CBS system but subsequently changes were made in the LCs by substantially increasing the amount and transmitted through SWIFT without reporting this to CBS.

According to the note, LoUs were opened for pearl import for which total time period allowed by RBI is 90 days. Some of the overseas branches of Indian banks overlooked the rule. PNB has alleged “clear criminal connivance” of group companies of Modi and Gitanjali with some officials of PNB and other banks. In what could lead to a feud between PNB and other Indian banks, the former has complained that some of the branches of other Indian banks have not shared key documents related to the credit with PNB.

It appears the overseas buyers’ credit against LoUs was used to retire import bills or replenish maturing credit.

Allahabad Bank has also issued a confidential note to other banks on the modus operandi of the fraud.

How The Fraud Will Hurt Business? Banks will clampdown on credit limits and insurance companies will turn cautious. On Wednesday, a large American insurance company alerted all its offices not to take any exposure to two companies linked to Nirav Modi and his associates, sources told ET.

It is unclear whether the insurer in question would wriggle out of its existing commitments (if any) on the grounds that there has been a fraud.

Echo of WinsomeExactly five years ago, in the summer of 2013, a consortium of Indian banks were hit when the Winsome group, a well-known diamond house, failed to repay a dozen lenders. Then too, PNB was hurt the most: Of the Rs 6,800 crore credit extended by the consortium led by Standard Chartered Bank, PNB has the highest exposure of Rs 1,800 crore. Some of the transactions have an uncanny similarity with the Winsome case: the banks had issued standby letters of credit — or SBLC which are similar to guarantees — in favour of international bullion banks which supplied gold to Winsome Group companies.

The arrangement was if Winsome failed to pay the bullion banks, Indian banks would step in to pay for the gold consignment. Eventually, banks in India were left holding the baby when Winsome claimed that they were unable to repay with their clients in the Middle East suffering huge losses on derivative bets. Like the Nirav Modi case, PNB had reported the transactions to the Central Bureau of Investigation (CBI) which is still investigating the case. Since then, Mehtas -- the family which founded Winsome -- never visited India, with some of them settling in Singapore and Dubai after taking citizenship of Saint Kitts. Modi, till last week, was in China, according to one of his fraternity members. Meanwhile, in Mumbai's diamond and bullion districts everyone is guessing how long would Modi and his uncle Mehul Choksi take to return to India.

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